Utility Stocks: Is There Any Steam Left in These Defensives?

The Utilities Select Sector SPDR ETF (XLU) represents the top utility stocks. XLU has been trading in a very narrow range for the last two weeks. These defensives might have calmed a little after a notable run this year. XLU has risen almost 20%, which is largely in line with the Dow Jones Index (DIA). However, the Fed has indicated a pause in interest rate cuts, which takes away one of the major drivers behind the sector’s rally this year.

Top utility gainers of 2019

Recently, most of the top utility stocks hit their all-time highs. The top constituents of XLU, Southern Company (SO) and NextEra Energy (NEE) stocks have risen more than 40% and 37%, respectively, this year. They’re some of the top gainers among utilities this year. Duke Energy (DUK) and Dominion Energy (D) have risen approximately 2% and 16% YTD. These four utility stocks form more than 36% in the Utilities ETF (XLU). To learn more, read Utility Stocks: Analyzing the Top Gainers in 2019.

Currently, XLU is trading at $63.0, which is marginally below its 50-day and 4% above its 200-day simple moving average levels. The faster moving average level close to $63.5 could act as a resistance for XLU in the short term. At the same time, the slower moving average level around $60.6 might act as a support.

With a few exceptions, XLU has always traded above both of its key support levels this year. However, XLU broke below its 50-day level last month, which might concern investors. The Fed’s decision to change its course and pause rate cuts resulted in notable weakness in utilities early last month.

Utility stocks: Dividends and valuation

XLU is trading at a dividend yield of 3%, which is notably higher than the benchmark Treasury yields. Utilities have remained in focus this year due to their stable dividends. Their earnings aren’t susceptible to business or economic cycles. As a result, utilities will likely pay decent dividends in the foreseeable future. To learn more about utilities’ dividends, read Two Top-Yielding Utility Stocks for Uncertain Markets.

Inflated valuations might hinder utilities’ rally going forward. Top utility stocks are trading close to 20x their forward earnings, which is higher than their five-year averages. NextEra Energy and Southern Company, the top-rallied utility stocks, are trading at a substantial premium compared to their historical averages. Also, paying close to 20x the earnings for slow growth companies doesn’t seem justified.

Utilities haven’t just outperformed this year, they have played out well in the long term as well. XLU returned almost 70% (including dividends) in the last five years, which is largely in line with the S&P 500.

Conclusion

However, despite the premium valuation, broader market developments will likely drive utility stocks in the short to medium term. The intensifying global slowdown and trade war tensions could boost the volatility in equities, which might force investors to defensive stocks. Notably, utilities’ earnings and dividends look stable, which might provide the necessary hedge in uncertain times.